EXECUTIVE WHITE PAPER

Employees come and go:For most employers, that’sa fact of business life. Andit’s also a fact that thereare costs associated withemployee turnover, both

tangible and intangible. Hiring involvesthe time and costs associated with inter-viewing, evaluating, and selecting newemployees. There are training costs tobring a new employee up to speed in ajob. And there are the less tangible costsof not having a skilled employee in thejob when you need one—costs that canbe measured in terms of customer satis-faction or lost customers.

All of these costs add up, even for

The Economicsof Retention

Improving economic conditions, an impending skilled labor shortage,and the proven link between low turnover and profitability are forcingorganizations to take a new look at employee retention. Sound retention strategies not only can head off a future problem, they cansave money and improve sales today.

lower-paid workers. Some sources put thecost of hiring and training an hourlyworker at 300 to 700 times the worker’shourly wage. HR.com, a human resourcesWeb site, has estimated that it costs twoto three times more to replace a workerthan to keep an existing employee—evenwhen you’re replacing an unproductiveemployee with one who is more efficient.

Turnover, and the costs associatedwith it, may be manageable during tighteconomic periods, when employees at alllevels are more likely to stay put. But whenthe economy improves, turnover increases,and it is often a company’s best employeesthat jump ship—especially if they are feel-ing underappreciated or undervalued.

The Looming Labor ShortageOn top of this economic ebb and flow

and its effect on employee turnover andretention, there is also the likelihood of asevere labor shortage in the U.S. by 2010.According to a 2000 Bureau of LaborStatistics study, there could be a shortageof four million workers by 2006, and by2010 there could be 10 million more jobs available than there are employees to fillthem in the U.S. A labor shortage ofthose dimensions will cause the cost ofacquiring new employees to skyrocket,and it will make having an effectiveemployee retention strategy critical to thesuccess of any business.

Putting a retention strategy in placetoday not only can head off potentialproblems later on, but provide almostimmediate benefits in terms of sales andcustomer satisfaction.

The Hidden Costs of TurnoverMany top executives secretly like

turnover. That’s why so many businessestolerate double-digit turnover rates everyyear. These executives believe thatturnover saves money by keeping theaverage employee on the low end of thepay scale. The longer an employee stays,the more they will earn. It’s easy to har-bor this point of view because it’s oftendifficult to truly measure the cost ofturnover over time.

In fact, the dollars-and-cents cost ofturnover differs from industry to industryand company to company—it can rangefrom a couple of thousand dollars to tensof thousands of dollars per employeelost—but in almost every case, the costwill be much more than the typicalemployer imagines.

� The Looming Labor Shortage� The Hidden Costs of Turnover� Turnover and Profitability� The Critical Elements� Performance-Based Retention� Where to Begin� Who’s in Charge

Inside this White Paper

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Here’s a rundown of some of the costs(both tangible and intangible) that havebeen connected with turnover:� Pre-departure costs—such as thereduced productivity of an employee whois discontented and using company timeto look for another job, plus the costs ofany efforts to retain the employee once heor she has announced his intent to leave.� Termination costs—those related totermination of employment, includingexit interviews, security precautions, paycalculations, and other recordkeepingcosts, plus the unemployment tax impactand payments for severance, accruedvacation time, retirement plan contribu-tions, and any extension to benefits.� Recruitment costs—related toadvertising, recruiting, interviewing, pre-employment evaluations, security andbackground checks, hiring bonuses, relocation, etc.� Training costs—the cost of trainingnew employees in necessary job skillscan be significant. � Productivity costs—related to newworkers, who are generally less productive,require more supervision, and contributeless to customer satisfaction.� Vacancy costs—lost sales or lost productivity while the position remainsvacant, plus the cost of overtime or temporary help to cover fill in.

The sum of these costs can amountto many times the employee’s salary whenfully loaded to reflect the resulting costsin terms of product quality, customer service, brand representation, and all ofthe other areas that suffer when anemployee leaves, as well as during thereplacement period.

Turnover and ProfitibilityEven those companies mindful of

turnover costs might overlook the impacton the bottom line. In a landmark studyinvolving a national food chain reportedin The Service Profit Chain: How LeadingCompanies Link Profit and Growth toLoyalty, Satisfaction, and Value, JamesHeskett, Earl Sasser, and Leonard

accounting systems, is larger than anystate or federal tax.” For instance:� Customer selection. Experiencedsalespeople and marketers, for instance,“are much better at finding and recruitingthe best customers,” Reichheld says.Bain & Company research has shownthis to be true in the life insurance indus-try, where policies written by new agentsare generally found to have a lower netvalue for insurers.� Customer retention. Long-termemployees have been shown to createhigher customer loyalty in such industriesas banking, brokering, and auto service.But even in manufacturing, Reichheldsays, “long-term employees can producebetter products, better value for the consumer, and better customer retention.”� Customer referrals. Loyal employeescan be a source of new customers.

When Reichheld’s firm examined“the economic penalties of excessiveemployee churn” at one trucking company, for example, it found that thecompany “could increase profits 50 percent by cutting driver turnover inhalf.” At a stock brokerage it found that“a 10 percentage point improvement inbroker retention (from 80 percent to 90percent) would increase a broker’s valueby 155 percent.”

The Critical ElementsWhat causes turnover? What factors

are likely to encourage an employee toremain with his current employer? Is it

EXECUTIVE WHITE PAPER

Schlesinger found that stores in the top20 percent for employee retention were55 percent more profitable than stores inthe bottom 20 percent.

The impact on customer relationshipsis especially visible with turnover amongsales or customer service employees.Customer relationships may be affected,customer satisfaction can decline, andsales or customers may be lost. In largepart, this is because of the knowledge and experience these employees havewith customers.

Turnover can affect other departmentsas well. In IT departments, for instance, adeparting employee may be leaving withknowledge of software code changes thatwill take months or years of experienceand training for a new employee toacquire.

As Frederick F. Reichheld, a directorof Bain & Company and author of TheLoyalty Effect: The Hidden Force BehindGrowth, Profits, and Lasting Value (HarvardBusiness School Press, 1996), found fromhis firm’s studies of a variety of indus-tries, “The true cash-flow consequencesof employee turnover far exceed mostmanager’s intuitive estimates. In fact, theturnover tax on corporate earnings, although invisible in most

Stores with higher retention rates were found togenerate higher profit margins.

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compensation, benefits, working condi-tions, or something else?

Compensation is undoubtedly a factor,particularly in highly competitive markets.A comparative analysis of wages andfinancial performance for Wal-MartStores Inc. and Costco Wholesale Corp.by Business Week magazine, for instance,found that the higher wage approachadopted by Costco has resulted in a work-force that is more loyal and more produc-tive. In fact, not only are Costco employeesmore highly paid, but while Sam’s Cluband Costco produce about the same revenues—$35 billion and $34 billion,respectively—Costco accomplishes thiswith one-third fewer employees. BusinessWeek asserts that “Costco [has] one of themost productive and loyal workforces inall of retailing. Only 6 percent of employeesleave after the first year, compared with 21percent at Wal-Mart.” And that “saves

tons, since Wal-Mart says it costs $2,500per worker just to test, interview, andtrain a new hire.”

Comparisons like this are one of thereasons that most employers blameemployee turnover on compensation andbenefits issues, while the truth is thatmost employees leave over dissatisfactionwith factors other than pay.

Noncash incentives may be moreeffective and less costly than increasingcompensation or offering cash incentivesto promote retention. According to theAmerican Productivity and QualityCenter in Houston and the AmericanCompensation Association, it takes anincrease of 5 to 8 percent of an employ-ee’s salary to change his behavior.However, using noncash incentives,behavior can be influenced at a cost ofonly 4 percent of the employee’s salary.

Performance-Based RetentionMany companies focus on retention

by addressing critical work-life issues such

as day care, health care, elder care, vaca-tions, flextime, sabbaticals, and charitablework. However, addressing work life issuesalone doesn’t necessarily align employeeretention with critical organizational goals.It’s not enough to have satisfied employees;success comes from having satisfiedemployees motivated to continuallyimprove performance. So, companiesseeking a performance-oriented approachto employee retention might seek toenhance work value in some of the following ways: � Employee involvement in job design,goal setting, and selection of rewards.� Clear communication about companygoals and ways employees can contributeto and share in its success.� Incentive programs that reward peoplefor significant and measurable performanceimprovements.� Recognition programs offering meaningful recognition to employees forboth tangible and intangible contributionsto their company.� Project-oriented approaches inwhich all employees can work on diverse,limited-term assignments rather thanbeing sequestered within a single depart-ment or function.� Developing talent exchanges toenhance careers by connecting employeeswith appropriate projects, roles, and positions within their companies. � Training through coordinated programsdesigned to enhance employee knowledgeand then rewarding employees for thatincreased knowledge. Consider cross-training to enhance skills and improveproductivity. This both satisfies employeesand equips them to perform better. � Fostering feelings of support by setting clear goals for employees andrewarding them upon accomplishment,and by promoting consistent values andrecognizing people who embody them.This directs retention resources to actionsand values that have a measurable benefitto the organization. � Creating an atmosphere of fun withspot “atta-boy” rewards, contests, or meet-ings, specifically related to organizationalgoals and values. This creates an atmos-phere conducive to retention while keepingthe focus on achieving goals. � Addressing the measurement issueby instituting “real-time” goal setting,

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The Role of MotivationHigher levels of motivation can translate into a 53 percent reductionin employee turnover, according to arecent study by Stephen Condly, associate professor at the Universityof Central Florida, Orlando, conductedfor the SITE Foundation. No retentionstrategy can succeed without addressingthe issue of employee motivation. “Incentives, Motivation, and WorkplacePerformance,” a study conducted by theprofessors at the University of SouthernCalifornia for the International Societyof Performance Improvement, foundthe following factors critical to fostering motivation and loyalty.

� Work value. The research confirmedthat people stay motivated when theyvalue their work, no matter how mundane the task. Someone building ahouse for low-income tenants mightget pleasure from the most arduouslabor, knowing the good that cancome from the effort. Organizationscan foster work value by recognizingcontributions in a meaningful way, and regularly communicating the organizational goals toward which eachemployee can contribute. They canadd to satisfaction through use ofincentive programs that set goals forquality or quantity, and reward thosewho achieve or surpass them.

� Training. Many people draw satis-faction from developing the capabilityto do their jobs better, or acquiringadditional skills or responsibility.

� Support. Most people gain satisfaction from knowing that theirorganization appreciates their effort.This often comes in the form of meaningful recognition to those whoachieve their goals or who exemplifyimportant organizational values.

� Emotional appeal. Yes, people workbetter when they feel happy. Properlystructured incentive and recognitionprograms can foster an atmosphere offun and excitement, even in dreary jobs.

� Measurement. Knowing how one isdoing in the pursuit of a goal is anotherway to create satisfaction. Effectivemeasures of quality and productivitykeep employees focused on goals,especially if accompanied with properrecognition when they succeed.

A trucking companycould increase profits50 percent by cuttingdriver turnover in half.

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EXECUTIVE WHITE PAPER

performance measurement, and skills-development programs to ensure thatpeople always know where they stand,and to address performance issues andskill gaps before they become problems.

Other key points: � Compensate fairly. No one said thatcompensation will have no effect onturnover and retention. Determine a fairwage in your labor market and do whatyou can to meet it. A fair and equitablewage and benefits package is the founda-tion for a successful employee retentionprogram.� Build trust. As mentioned above, a“climate of trust” is one of the factors thatinfluence employee retention. Trust is built

with employees through fair working con-ditions, management responsiveness toemployee concerns, realistic performanceexpectations, and open communication,including one-on-one communicationsbetween managers and employees when-ever possible.� Don’t limit motivation efforts to staremployees. Incentive, reward, and recog-nition programs should be expanded toinclude as many employees as possible,rather than just the top 5 or 10 percent.Remember, it’s that large middle range ofemployees that can contribute the mostin terms of improved productivity andlower turnover costs.

Where to BeginThe best place to begin an employee

retention strategy is with an evaluation ofthe whole corporate environment and anaudit of all of the practices and programsthat impact employees. Typically, this will mean reviewing all incentive and

recognition programs, benefits and wellness packages (from insurance to timeoff), compensation packages, and otherstructures.

Another helpful process is to assessthe organization’s cultural vitality, includ-ing employee perceptions about the company and its offerings. Identify theissues that might contribute to employee turnover, and conduct a sur-vey. If people are leaving the organization,

why are they leaving? Are theretrends in these separations?

It’s also important to start atthe top of your organization. A company-wide employee retention program will not succeed withoutvisible senior officer commitment.The results of your company’saudit of the costs associated withemployee turnover —both tangibleand intangible—should be enoughto convince top executives thattheir return on investment in aretention strategy will be significant.

Who’s in ChargeTurnover traditionally

is viewed as a humanresources issue, but it isalso a sales and marketingissue. Many organizationslack the cooperationbetween external and internal marketing neces-sary not only to create anatmosphere conducive toretention but to better linkretention strategies to mea-sure sales and marketingoutcomes, i.e., increasedsales, customer retention,profit margins, etc.

The real ownership ofan employee retention pro-gram, however, should fallto the department or theexecutive with the most atstake in terms of the cost

of turnover and the value of employeeretention—whether that’s with sales, customer service, manufacturing, ware-house management, retail operations, orelsewhere. Some have suggested thatownership reside in a coalition of HR andmarketing because it is important forcompanies to understand that they needto market themselves to employees justas if they were an important customersegment.

No matter who oversees the retentionprogram, it’s important to understand that its success will rely on the efforts offrontline managers and supervisorsacross your organization. Training managers on retention tactics and holdingthem responsible for implementing aretention strategy will be critical.

Based on the compelling economicsof reducing employee turnover, it shouldn’ttake a labor shortage to force companiesto wake up to the benefits. Many companies that fail to understand the economics might have no choice in thecoming years, when they find themselvescontinually outbid for the best employeesin their area.

Higher levels of motivation can result in a 53percent reduction in turnover.

The Performance Improvement Council

This White Paper was put together under the auspicesand with the input of the Performance ImprovementCouncil, a unit of the Incentive Marketing Association.

Members include: Carlson Marketing Group (www.carlsonmarketing.com)Dittman Incentive Marketing (www.dittmanincentives.com)EGR International (www.egrinternational.com)The Incentive Group (www.incentivegroup.com)ITA Group (www.itagroup.com)Maritz Incentives (www.maritz.com)Marketing Innovators (www.marketinginnovators.com)MotivAction (www.motivaction.com)Motivation Excellence (www.meiweb.com)USMotivation (www.usmotivation.com)

The members of the Performance Improvement Council arededicated to offering companies solutions-based incentiveand performance improvement programs.